A taxpayer has a net §1231 gain of $20,000 in Year 5. In Years 1-4, the taxpayer had net §1231 losses of $8,000 (Year 1) and $4,000 (Year 2), which were deducted as ordinary losses. What is the character of the Year 5 gain?

Answer options:

$20,000 Capital Gain

$20,000 Ordinary Income

$12,000 Ordinary Income; $8,000 Capital Gain

$12,000 Capital Gain; $8,000 Ordinary Income

How to approach this question

§1231 Lookback Rule: Current §1231 gain is Ordinary to the extent of unrecaptured §1231 losses from the previous 5 years.

Full Answer

C.$12,000 Ordinary Income; $8,000 Capital Gain✓ Correct

IRC §1231(c). Total unrecaptured losses = $12,000. The first $12,000 of the Year 5 gain is recharacterized as ordinary income. The remaining $8,000 is long-term capital gain.

Common mistakes

Forgetting the 5-year lookback rule.

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